Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
In this Quarterly Report on Form 10-Q, except where the context suggests otherwise, "EARN," "we," "us," and "our" refer to Ellington Residential Mortgage REIT and its subsidiaries, our "Manager" refers to Ellington Residential Mortgage Management LLC, our external manager, and "Ellington" refers to Ellington Management Group, L.L.C. and its affiliated investment advisory firms.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
When used in this quarterly report on Form 10-Q, in future filings with the Securities and Exchange Commission ("SEC") or in press releases or other written or oral communications, statements which are not historical in nature, including those containing words such as "believe," "expect," "anticipate," "estimate," "project," "plan," "continue," "intend," "should," "would," "could," "goal," "objective," "will," "may," "seek" or similar expressions, are intended to identify "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, or the "Securities Act," and Section 21E of the Securities Exchange Act of 1934, as amended, and, as such, may involve known and unknown risks, uncertainties, and assumptions.
Forward-looking statements are based on our beliefs, assumptions, and expectations of our future performance, taking into account all information currently available to us. These beliefs, assumptions and expectations are subject to risks and uncertainties and can change as a result of many possible events or factors, not all of which are known to us. If a change occurs, our business, financial condition, liquidity and results of operations may vary materially from those expressed in our forward-looking statements. The following factors are examples of those that could cause actual results to vary from our forward-looking statements: changes in interest rates and the market value of our securities; our use and dependence on leverage; the impact of Fannie Mae and Freddie Mac being placed into conservatorship and related events, including the lack of certainty as to the future roles and structures of these entities and changes to legislation and regulations affecting these entities; market volatility; changes in the prepayment rates on the mortgage loans underlying the securities we own and intend to acquire; changes in rates of default and/or recovery rates on our non-agency assets; our ability to borrow to finance our assets and the costs of such borrowings; changes in government regulations affecting our business; our ability to maintain our exclusion from registration under the Investment Company Act of 1940, as amended (the "Investment Company Act"); and risks associated with investing in real estate related assets, including changes in business conditions and the general economy. These and other risks, uncertainties and factors, including the risk factors described under Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2016 as filed with the SEC, could cause our actual results to differ materially from those projected in any forward-looking statements we make. All forward-looking statements speak only as of the date on which they are made. New risks and uncertainties arise over time and it is not possible to predict those events or how they may affect us. Except as required by law, we are not obligated to, and do not intend to, update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
Executive Summary
We are a Maryland real estate investment trust, or "REIT," formed in August 2012 that specializes in acquiring, investing in, and managing residential mortgage- and real estate-related assets. Our primary objective is to generate attractive current yields and risk-adjusted total returns for our shareholders by making investments that we believe compensate us appropriately for the risks associated with them. We seek to attain this objective by constructing and actively managing a portfolio comprised primarily of residential mortgage-backed securities, or "RMBS," for which the principal and interest payments are guaranteed by a U.S. government agency or a U.S. government-sponsored entity, or "Agency RMBS," and, to a lesser extent, RMBS that do not carry such guarantees, or "non-Agency RMBS," such as RMBS backed by prime jumbo, Alternative A-paper, manufactured housing, and subprime residential mortgage loans. We also may opportunistically acquire and manage other types of residential mortgage-related and real estate-related asset classes, such as residential mortgage loans, and mortgage servicing rights, or "MSRs." We believe that being able to combine Agency RMBS with non-Agency RMBS and other residential mortgage- and real estate-related asset classes enables us to balance a range of mortgage-related risks.
We were formed through an initial strategic venture among affiliates of Ellington, an investment management firm and registered investment adviser with a 22-year history of investing in a broad spectrum of MBS and related derivatives, with an emphasis on the RMBS market, and the Blackstone Tactical Opportunity Funds, or the "Blackstone Funds." As of
June 30, 2017
, the Blackstone Funds owned approximately 22% of our outstanding common shares. We are externally managed and advised by our Manager, an affiliate of Ellington.
During the three month period ended June 30 2017, we completed a follow-on common share offering whereby we sold 3,230,000 shares for net proceeds of $45.0 million, after offering costs and underwriters' discounts. We fully deployed the net proceeds from the offering during the second quarter in our targeted assets.
We use leverage in our Agency RMBS strategy and, while we have not done so meaningfully to date, we may use leverage in our non-Agency RMBS strategy as well, although we expect such leverage to be lower. We have financed our purchases of Agency RMBS exclusively through repurchase agreements, which we account for as collateralized borrowings. As of
June 30, 2017
, we had outstanding borrowings under repurchase agreements in the amount of
$1.6 billion
with
thirteen
counterparties.
We have elected to be taxed as a REIT for U.S. federal income tax purposes. Accordingly, we generally will not be subject to U.S. federal income taxes on our taxable income that we distribute currently to our shareholders as long as we maintain our qualification as a REIT. We intend to conduct our operations so that neither we nor any of our subsidiaries is required to register as an investment company under the Investment Company Act.
As of
June 30, 2017
, our book value per share was $14.71 as compared to $15.35 as of March 31, 2017 and $15.52 as of December 31, 2016.
Trends and Recent Market Developments
Key trends and recent market developments for the MBS market include the following:
|
|
•
|
U.S. Federal Reserve and U.S. Monetary Policy—
In June 2017, the U.S. Federal Reserve, or "Federal Reserve," raised its target range for the federal funds rate by 0.25% and provided a balance sheet normalization plan. In July 2017, the Federal Reserve indicated that it may begin to taper its bond holdings relatively soon, provided that the economy continues to improve;
|
|
|
•
|
Housing and Mortgage Market Statistics—
Data released by S&P Dow Jones Indices for its S&P CoreLogic Case-Shiller Indices for May showed a continuation of mid-single-digit home price appreciation nationally; meanwhile, mortgage rates declined over the course of the second quarter, with the Freddie Mac survey 30-year mortgage rate falling 26 basis points to end the quarter at 3.88%;
|
|
|
•
|
Prepayment Rate Trends—
Prepayment rates increased slightly in the second quarter, largely driven by seasonal factors and lower mortgage rates;
|
|
|
•
|
Portfolio Overview and Outlook
—During the second quarter, Agency RMBS remained one of the few fixed-income asset classes trading at the wider end of their trailing two-year range, with their option-adjusted spreads relatively unchanged quarter over quarter. Non-Agency RMBS yield spreads continued to grind tighter, as did those for many other credit products such as CMBS. As of June 30, 2017, the value of our long Agency bond portfolio was $1.632 billion, as compared to $1.214 billion as of March 31, 2017 and as of June 30, 2017, the value of our investment in non-Agency RMBS was $20.6 million as compared to $16.0 million as of March 31, 2017.
|
Federal Reserve and U.S. Monetary Policy
On June 14, 2017, the Federal Open Market Committee, or "FOMC," announced that it would raise the target range for the federal funds rate by 0.25%, to 1.00%–1.25%. This was a third consecutive quarterly increase in the target range for the federal funds rate. The FOMC also released its Policy Normalization Principles and Plans, which describes a plan to reduce the Federal Reserve's U.S. Treasury and Agency securities holdings gradually by decreasing reinvestment of the principal payments received from securities held in the System Open Market Account. Specifically, such payments will be reinvested only to the extent that they exceed gradually rising caps. For payments of principal received from holdings of Agency debt and mortgage-backed securities, the anticipated cap will be $4 billion per month initially and will increase by increments of $4 billion at three-month intervals over 12 months until the cap reaches $20 billion per month. The FOMC also anticipates that the caps (including a similar concept for U.S. Treasuries) will remain in place once they reach their respective maximums so that holdings will continue to decline in a gradual and predictable manner, until the FOMC judges that the Federal Reserve is holding no more securities than is necessary to implement monetary policy efficiently and effectively.
On July 26, 2017, the FOMC maintained the target range for the federal funds rate at 1.00%–1.25%. In its statement following the meeting, the FOMC indicated that economic activity has been rising moderately, job gains have been solid, and the unemployment rate has continued to decline. However, overall inflation has declined on a 12-month basis and is running below the committee's stated two percent longer-run objective. The FOMC reiterated that with gradual adjustments in monetary policy, it expects the expansion of economic activity to continue at a moderate pace, labor market conditions to continue to strengthen moderately, and inflation to stabilize around two percent over the medium term. The FOMC also expects economic conditions to evolve in such a way that only gradual increases in the federal funds rate would be warranted, and that the federal funds rate is likely to remain, for some time, below expected longer-run levels. While the FOMC maintained its existing policy of reinvesting principal payments from its holdings of Agency debt and Agency mortgage-backed securities it stated that it expects to begin implementing its balance sheet normalization program relatively soon, provided that the economy performs as anticipated.
Housing and Labor Market Statistics
Data released by S&P Dow Jones Indices for its S&P CoreLogic Case-Shiller Indices for May 2017 showed that, on average, home prices posted a 5.7% year-over-year increase for its 20-City Composite and a 4.9% year-over-year increase for its 10-City Composite, after seasonal adjustments. We believe that near-term home price trends are more likely to be driven by fundamental factors such as economic growth, mortgage rates, and affordability, rather than by technical factors such as foreclosure inventory.
On July 7, 2017, the U.S. Bureau of Labor Statistics, or "BLS," reported that, in June 2017, the U.S. unemployment rate was 4.4%, down from 4.9% a year earlier. The unemployment rate of 4.4% was slightly higher than a 16-year low reached in May 2017 of 4.3%, and represents a level generally considered consistent with an economy operating at or near full employment. In light of the drop in the labor force participation rate since the financial crisis, another, perhaps more relevant, measure of labor market conditions is employment growth. The BLS also reported that non-farm payrolls rose by 222,000 in June 2017, which suggests that the labor market is returning to a more sustainable pace of growth that could support continued gains in consumer spending in the coming months. Over the past three months, job gains have averaged 194,000 per month.
Prepayment Rate Trends
As shown in the table below, prepayment rates for both low loan balance specified and non-specified pools decreased slightly from March to April, but then increased in May and June and ended the second quarter slightly higher than the end of the first quarter. The small increase can be attributed partially to lower mortgage rates as well as seasonal factors in the second quarter, which typically includes a portion of the peak home sale activity for the year.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Prepayment Rates
|
Description
|
|
Vintage
|
|
Collateral
|
|
Balance
|
|
Loan-to-Value
|
|
FICO
|
|
Jun 2017
|
|
May 2017
|
|
Apr 2017
|
|
Mar 2017
|
|
|
|
|
|
|
(In billions)
|
|
|
|
|
|
|
|
|
|
|
|
|
FNMA 30-Year 3.5%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2014
|
|
Non-Specified
|
|
41.9
|
|
78
|
|
|
760
|
|
|
15.8
|
|
13.5
|
|
11.0
|
|
11.9
|
|
|
2014
|
|
Low Loan Balance
|
|
0.5
|
|
69
|
|
|
756
|
|
|
12.6
|
|
10.2
|
|
8.3
|
|
10.9
|
FNMA 30-Year 4.0%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2014
|
|
Non-Specified
|
|
45.3
|
|
80
|
|
|
741
|
|
|
19.1
|
|
17.7
|
|
15.1
|
|
17.0
|
|
|
2014
|
|
Low Loan Balance
|
|
2.5
|
|
73
|
|
|
741
|
|
|
12.5
|
|
12.4
|
|
10.8
|
|
11.9
|
Source: J.P. Morgan
The Mortgage Bankers Association's Refinance Index, which measures refinancing application volumes on a weekly basis, increased 9.4% in the second quarter, as shown in the table below. The index has increased steadily throughout the first half of 2017 from a multi-year low reached on December 23, 2016, but at the end of the second quarter was still meaningfully lower than a multi-year high reached on July 8, 2016.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of
|
|
|
June 30,
2017
|
|
March 31,
2017
|
|
December 31, 2016
|
|
September 30, 2016
|
|
June 30,
2016
|
MBA Refinance Index
|
|
1,391.0
|
|
|
1,271.9
|
|
|
1,132.0
|
|
|
2,380.1
|
|
|
2,136.4
|
|
Source: Mortgage Bankers Association
Portfolio Overview and Outlook
General Market Overview
Volatility continued to hit new lows in the second quarter. The Merrill Lynch Option Volatility Estimate Index, or MOVE Index, sunk to a four year low, and the Chicago Board Options Exchange Volatility Index, known as the VIX, dropped to its lowest level in 23 years, while longer-term interest rates and MBS price volatility also declined. The 10-year U.S. Treasury traded in a 29 basis point band during the quarter, which was one of the tightest ranges for a quarter in the past 40 years. The 2-year U.S. Treasury yield rose 13 basis points to end the quarter at 1.38%, whereas the 10-year U.S. Treasury yield fell 9 basis points to 2.30%.
Non-Agency RMBS yield spreads continued to grind tighter, as did those for many other credit products such as CMBS, while demand remained strong for floating-rate debt instruments, including CLOs and leveraged loans. The energy-related sectors of the corporate bond market were notable exceptions to this trend, as yield spreads in these sectors widened in response to sharp declines in oil prices. Meanwhile, Agency RMBS remained one of the few fixed-income asset classes trading at the wider end of their trailing two-year range, with their option-adjusted spreads relatively unchanged quarter over quarter. We largely attribute the relative underperformance of Agency RMBS to concerns around the Federal Reserve's plan for tapering its asset purchases.
Agency
As of June 30, 2017, the value of our long Agency bond portfolio was $1.632 billion, as compared to $1.214 billion as of March 31, 2017.
Consistent with past quarters, as of June 30, 2017, our Agency RMBS portfolio consisted principally of "specified pools," particularly those with higher coupons. Specified pools are fixed-rate Agency pools consisting of mortgages with special characteristics, such as mortgages with low loan balances, mortgages backed by investor properties, mortgages originated through the government-sponsored MHA refinancing programs, and mortgages with various other characteristics.
In the second quarter, Agency RMBS option-adjusted spreads were relatively unchanged from the prior quarter, and continued to trade at the wider end of their trailing two year range. It is our view that fears related to the uncertainty of the Federal Reserve's tapering of its Agency RMBS reinvestments contributed to the underperformance of the asset class during the second quarter. Despite the anticipated reduced support from the Federal Reserve, we do not expect that Agency RMBS option-adjusted spreads will widen substantially, as they did during the 2013 "Taper Tantrum," largely because the investor base for Agency RMBS has changed substantially since then. Agency RMBS ownership has largely shifted away from investors such as the GSEs, certain money managers, and mortgage REITs whose activities, including delta-hedging and utilization of high degrees of leverage, tend to amplify price swings during periods of high volatility.
While pay-ups on specified pools edged higher quarter over quarter, the increase was less than might have been expected given the drop in mortgage rates. Pay-ups are price premiums for specified pools relative to their TBA counterparts. Average pay-ups on our specified pools increased to 0.71% as of June 30, 2017, from 0.68% as of March 31, 2017. The underperformance of specified pools relative to TBAs dampened our results for the second quarter, given that TBA short positions are a major component of our interest rate hedging portfolio. We believe that this underperformance of prepayment-protected specified pools can be attributed to the drop in volatility, which has made many investors complacent that mortgage rates are unlikely to move sufficiently downward to trigger a new prepayment wave. However, both the decline in long-term interest rates and the drop in implied volatility drove mortgage rates quite a bit lower during the second quarter, and the recent flattening of the yield curve signals a higher probability of further declines in mortgage rates, so we believe that the specified pool market may be underappreciating the risk of another prepayment wave.
Our view remains favorable for specified pools despite their second quarter underperformance. While the Federal Reserve's Agency RMBS purchasing is now forecast to decline in the fourth quarter of this year, its purchases have always been in TBAs, not specified pools. The Agency pools that are delivered into TBA contracts are viewed as the most vulnerable to prepayments, but the Federal Reserve is relatively indifferent to these quality differences. As the Federal Reserve's buying subsides, we expect that the new marginal buyers of Agency RMBS will be more sensitive to these quality differences, which should be supportive of pay-ups and should therefore benefit our portfolio.
For the quarter ended June 30, 2017, we had total net realized and unrealized gains of $3.6 million, or $0.33 per share, on our aggregate Agency RMBS portfolio. Slightly higher asset valuations during the period led to the net gains. During the quarter we continued to hedge interest rate risk, primarily through the use of interest rate swaps and short positions in TBAs, and to a lesser extent, short positions in U.S. Treasury securities. For the quarter, we had total net realized and unrealized losses of $(8.1) million, or $(0.76) per share, on our interest rate hedging portfolio. In our hedging portfolio, the relative proportion (based on 10-year equivalents
1
) of TBA short positions decreased quarter over quarter relative to interest rate swaps. We believe that it is important to be able to hedge our Agency RMBS portfolio using a variety of instruments, including TBAs.
1
"10-year equivalents" for a group of positions represent the amount of 10-year U.S. Treasury securities that would experience a similar change in market value under a standard parallel move in interest rates.
During the second quarter, we completed a follow-on equity offering, raising approximately $45 million, net of underwriters' discounts and offering costs, and in order to maintain our desired leverage ratio, we also increased our repo borrowings. We principally used the net proceeds of the offering and repo borrowings to increase our investments in fixed-rate specified pools, particularly those with higher coupons. The weighted average coupon on our fixed-rate specified pools was 3.9% as of June 30, 2017, unchanged from the prior quarter. Our Agency RMBS portfolio continues to include a small
allocation to Agency IOs. Some of the IOs that we hold are backed by seasoned Ginnie Mae pools that have demonstrated some level of "burnout." Burnout often occurs after periods of high prepayments, when the mix of loans remaining in an RMBS pool becomes more concentrated in loans that tend to prepay more slowly; burnout can reflect a variety of factors, including the behavior of individual borrowers and overall trends in the mortgage banking industry. Our Agency IOs not only contribute to our portfolio in the form of their yields, but they also inherently serve as portfolio market value hedges in a rising interest rate environment.
In addition to deploying the proceeds from our follow-on equity offering, we actively traded our Agency RMBS portfolio during the quarter in order to capitalize on sector rotation opportunities. Our portfolio turnover for the quarter was 50% (as measured by sales and excluding paydowns). Our portfolio selection continues to be informed by mortgage industry trends—including significant enhancements in technology that are helping streamline the origination process—and we note that refinancing capacity remains high, with employment in the mortgage industry near a post-financial crisis high.
We expect to continue to target specified pools that, based on our prepayment projections, should: (1) generate attractive yields relative to other Agency RMBS and U.S. Treasury securities, (2) have less prepayment sensitivity to government policy shocks, and/or (3) create opportunities for trading gains once the market recognizes their value, which for newer pools may come only after several months, when actual prepayment experience can be observed. We believe that our research team, proprietary prepayment models, and extensive databases remain essential tools in our implementation of this strategy.
The following table summarizes prepayment rates for our portfolio of fixed-rate specified pools (excluding those backed by reverse mortgages) for the three month periods ended June 30, 2017, March 31, 2017, December, 31, 2016, September 30, 2016, and June 30, 2016.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Month Period Ended
|
|
|
June 30,
2017
|
|
March 31,
2017
|
|
December 31, 2016
|
|
September 30, 2016
|
|
June 30,
2016
|
Three Month Constant Prepayment Rates
(1)
|
|
8.2
|
%
|
|
12.7
|
%
|
|
15.6
|
%
|
|
14.1
|
%
|
|
10.1
|
%
|
|
|
(1)
|
Excludes Agency fixed-rate RMBS without any prepayment history.
|
The following table provides details about the composition of our portfolio of fixed-rate specified pools (excluding those backed by reverse mortgages) as of
June 30, 2017
and March 31, 2017.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2017
|
|
March 31, 2017
|
|
Coupon
|
|
Current Principal
|
|
Fair Value
|
|
Weighted
Average Loan
Age (Months)
|
|
Current Principal
|
|
Fair Value
|
|
Weighted
Average Loan
Age (Months)
|
|
|
|
(In thousands)
|
|
|
|
(In thousands)
|
|
|
Fixed-rate Agency RMBS:
|
|
|
|
|
|
|
|
|
|
15-year fixed-rate mortgages:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3.00
|
|
|
$
|
47,786
|
|
|
$
|
49,163
|
|
|
16
|
|
|
$
|
40,994
|
|
|
$
|
42,144
|
|
|
20
|
|
|
3.50
|
|
|
116,315
|
|
|
121,868
|
|
|
19
|
|
|
78,797
|
|
|
82,633
|
|
|
25
|
|
|
4.00
|
|
|
10,312
|
|
|
10,901
|
|
|
31
|
|
|
9,453
|
|
|
10,046
|
|
|
32
|
|
Total 15-year fixed-rate mortgages
|
|
|
174,413
|
|
|
181,932
|
|
|
19
|
|
|
129,244
|
|
|
134,823
|
|
|
24
|
|
20-year fixed-rate mortgages
|
4.00
|
|
|
9,721
|
|
|
10,359
|
|
|
24
|
|
|
10,045
|
|
|
10,678
|
|
|
21
|
|
30-year fixed-rate mortgages:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2.50
|
|
|
1,587
|
|
|
1,552
|
|
|
8
|
|
|
1,597
|
|
|
1,548
|
|
|
5
|
|
|
3.00
|
|
|
16,341
|
|
|
16,421
|
|
|
22
|
|
|
13,277
|
|
|
13,241
|
|
|
21
|
|
|
3.50
|
|
|
442,995
|
|
|
458,090
|
|
|
16
|
|
|
278,198
|
|
|
286,718
|
|
|
19
|
|
|
4.00
|
|
|
529,251
|
|
|
560,897
|
|
|
14
|
|
|
398,766
|
|
|
421,328
|
|
|
18
|
|
|
4.50
|
|
|
238,047
|
|
|
256,911
|
|
|
20
|
|
|
178,097
|
|
|
192,282
|
|
|
25
|
|
|
5.00
|
|
|
41,977
|
|
|
46,032
|
|
|
42
|
|
|
44,159
|
|
|
48,437
|
|
|
39
|
|
|
5.50
|
|
|
1,367
|
|
|
1,515
|
|
|
125
|
|
|
1,461
|
|
|
1,620
|
|
|
122
|
|
|
6.00
|
|
|
844
|
|
|
961
|
|
|
129
|
|
|
850
|
|
|
973
|
|
|
126
|
|
Total 30-year fixed-rate mortgages
|
|
|
1,272,409
|
|
|
1,342,379
|
|
|
17
|
|
|
916,405
|
|
|
966,147
|
|
|
21
|
|
Total fixed-rate Agency RMBS
|
|
|
$
|
1,456,543
|
|
|
$
|
1,534,670
|
|
|
17
|
|
|
$
|
1,055,694
|
|
|
$
|
1,111,648
|
|
|
21
|
|
Our net Agency premium as a percentage of the fair value of our specified pool holdings is one metric that we use to measure the overall prepayment risk of our specified pool portfolio. Net Agency premium represents the total premium (excess of market value over outstanding principal balance) on our specified pool holdings less the total premium on related net short TBA positions. The lower our net Agency premium, the less we believe that our specified pool portfolio is exposed to market-wide increases in Agency RMBS prepayments. As of
June 30, 2017
, our net Agency premium as a percentage of fair value of our specified pool holdings was approximately 3.7%, as compared to 3.4%, as of
March 31, 2017
. Excluding TBA positions used to hedge our specified pool holdings, our Agency premium as a percentage of fair value was approximately 5.2% and 5.1% as of
June 30, 2017
and
March 31, 2017
, respectively. Our Agency premium percentage and net Agency premium percentage may fluctuate from period to period based on a variety of factors, including market factors such as interest rates and mortgage rates, and, in the case of our net Agency premium percentage, based on the degree to which we hedge prepayment risk with short TBAs. We believe that our focus on purchasing pools with specific prepayment characteristics provides a measure of protection against prepayments.
We believe that our adaptive and active style of portfolio management is well suited to the current MBS market environment, which continues to be shaped by heightened prepayment risk, shifting central bank and government policies, regulatory changes, and developing technologies.
Non-Agency
Our non-Agency RMBS performed well in the second quarter, driven by net carry and realized and unrealized gains. As the case has been for some time, the fundamentals underlying non-Agency RMBS, led by a stable housing market, continue to be strong. We added slightly to this portfolio over the course of the second quarter, and as a result our total investment in non-
Agency RMBS was $20.6 million as of
June 30, 2017
, as compared to $16.0 million as of
March 31, 2017
. To the extent that more attractive entry points develop in non-Agency RMBS, we may further increase our capital allocation to this sector.
Financing
Over the course of the quarter our cost of repo financing increased as LIBOR increased. Our average borrowing cost for the three month period ended
June 30, 2017
was 1.09% as compared to 0.94% for the three month period ended March 31, 2017.
While large banks still dominate the repo market, non-bank firms, not subject to the same regulations as banks, are becoming more active in providing repo financing. The vast majority of our outstanding repo financing is still provided by banks and bank affiliates; however, in limited amounts, we have also entered into repo agreements with non-bank dealers. In general, we continue to see strong appetite and competitive terms from both types of lenders.
Our debt-to-equity ratio was to 9.0:1 as of
June 30, 2017
as compared to 8.4:1 as of
March 31, 2017
. Adjusted for unsettled security purchases and sales, our debt-to-equity ratio was 8.5:1 as of
June 30, 2017
and 8.2:1 as of
March 31, 2017
. Our leverage ratio may fluctuate period over period based on portfolio management decisions, market conditions, and the timing of security purchase and sale transactions.
Critical Accounting Policies
Our consolidated financial statements have been prepared in conformity with generally accepted accounting principles in the United States of America, or "U.S. GAAP." Entities in which we have a controlling financial interest, through ownership of the majority of the entities' voting equity interests, or through other contractual right that give us control, are consolidated by us. All inter-company balances and transactions have been eliminated.
Certain of our critical accounting policies require management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. We believe that all of the decisions and assessments upon which our consolidated financial statements are based were reasonable at the time made based upon information available to us at that time. We rely on our Manager and Ellington's experience and analysis of historical and current market data in order to arrive at what we believe to be reasonable estimates. See Note 2 of the notes to our consolidated financial statements included in this Quarterly Report on Form 10-Q for a complete discussion of our significant accounting policies. We have identified our most critical accounting policies to be the following:
Valuation
: For financial instruments that are traded in an "active market," the best measure of fair value is the quoted market price. However, many of our financial instruments are not traded in an active market. Therefore, management generally uses third-party valuations when available. If third-party valuations are not available, management uses other valuation techniques, such as the discounted cash flow methodology. Summary descriptions, for the various categories of financial instruments, of the valuation methodologies management uses in determining fair value of our financial instruments are detailed in Note 2 of the notes to our consolidated financial statements. Management utilizes such methodologies to assign a good faith fair value (the estimated price that, in an orderly transaction at the valuation date, would be received to sell an asset, or paid to transfer a liability, as the case may be) to each such financial instrument.
See the notes to our consolidated financial statements for more information on valuation techniques used by management in the valuation of our assets and liabilities.
Accounting for Securities
: Investments in mortgage-backed securities are recorded on trade date. We have chosen to make a fair value election pursuant to ASC 825-10,
Financial Instruments
, for our mortgage-backed securities portfolio. Electing the fair value option allows us to record changes in fair value in our Consolidated Statement of Operations, which, in our view, more appropriately reflects the results of our operations for a particular reporting period as all securities activities will be recorded in a similar manner. As such, the mortgage-backed securities are recorded at fair value on our Consolidated Balance Sheet and the period change in fair value is recorded in current period earnings on our Consolidated Statement of Operations as a component of Change in net unrealized gains (losses) on securities.
Realized gains or losses on sales of mortgage-backed securities are included in Net realized gains (losses) on securities on the Consolidated Statement of Operations, and are recorded at the time of disposition. The cost of positions sold is calculated based on identified cost. Principal write-offs are generally treated as realized losses.
Interest Income
: Coupon interest income on investment securities is accrued based on the outstanding principal balance and the current coupon rate on each security. We amortize purchase premiums and accrete purchase discounts on our fixed income investments using the effective interest method.
Our accretion of discounts and amortization of premiums on securities for U.S. federal and other tax purposes is likely to differ from the accounting treatment under U.S. GAAP of these items as described above.
See the Note 2 of the notes to our consolidated financial statements for more information on the assumptions and methods that we use to amortize purchase premiums and accrete purchase discounts.
Income Taxes
: We made an election to be taxed as a REIT for U.S. federal income tax purposes. As a REIT, we generally are not subject to corporate-level federal and state income tax on net income we distribute to our shareholders. To qualify as a REIT, we must meet a number of organizational and operational requirements, including a requirement to distribute at least 90% of our taxable income to our shareholders. Even if we qualify as a REIT, we may be subject to certain federal, state, local and foreign taxes on our income and property and to federal income and excise taxes on our undistributed taxable income. If the Company fails to qualify as a REIT, and does not qualify for certain statutory relief provisions, it will be subject to U.S. federal, state, and local income taxes and may be precluded from qualifying as a REIT for the four taxable years following the year in which the Company fails to qualify as a REIT.
We follow the authoritative guidance on accounting for and disclosure of uncertainty on tax positions, which requires management to determine whether a tax position is more likely than not to be sustained upon examination by the applicable taxing authority, including resolution of any related appeals or litigation processes, based on the technical merits of the position. For uncertain tax positions, the tax benefit to be recognized is measured as the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement. The Company did not have any unrecognized tax benefits resulting from tax positions related to the current period or to 2016, 2015, 2014, or 2013 (its open tax years). In the normal course of business, we may be subject to examination by federal, state, local, and foreign jurisdictions, where applicable, for the current period, 2016, 2015, 2014, and 2013 (our open tax years). We may take positions with respect to certain tax issues which depend on legal interpretation of facts or applicable tax regulations. Should the relevant tax regulators successfully challenge any such positions; we might be found to have a tax liability that has not been recorded in the accompanying consolidated financial statements. Also, management's conclusions regarding the authoritative guidance may be subject to review and adjustment at a later date based on changing tax laws, regulations, and interpretations thereof. There were no amounts accrued for penalties or interest as of or during the periods presented in the consolidated financial statements included in this Quarterly Report on Form 10-Q.
Recent Accounting Pronouncements
Refer to the notes to our consolidated financial statements for a description of relevant recent accounting pronouncements.
Financial Condition
Investment portfolio
The following tables summarize our mortgage-backed securities portfolio of as of
June 30, 2017
and December 31, 2016:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2017
|
|
December 31, 2016
|
(In thousands)
|
Current Principal
|
|
Fair Value
|
|
Average Price
(1)
|
|
Cost
|
|
Average Cost
(1)
|
|
Current Principal
|
|
Fair Value
|
|
Average Price
(1)
|
|
Cost
|
|
Average Cost
(1)
|
Agency RMBS
(2)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
15-year fixed-rate mortgages
|
$
|
174,413
|
|
|
$
|
181,932
|
|
|
$
|
104.31
|
|
|
$
|
182,470
|
|
|
$
|
104.62
|
|
|
$
|
141,829
|
|
|
$
|
148,363
|
|
|
$
|
104.61
|
|
|
$
|
148,873
|
|
|
$
|
104.97
|
|
20-year fixed-rate mortgages
|
9,721
|
|
|
10,359
|
|
|
106.56
|
|
|
10,461
|
|
|
107.61
|
|
|
10,488
|
|
|
11,185
|
|
|
106.65
|
|
|
11,275
|
|
|
107.50
|
|
30-year fixed-rate mortgages
|
1,272,409
|
|
|
1,342,379
|
|
|
105.50
|
|
|
1,348,714
|
|
|
106.00
|
|
|
888,976
|
|
|
940,457
|
|
|
105.79
|
|
|
948,157
|
|
|
106.66
|
|
ARMs
|
27,375
|
|
|
28,591
|
|
|
104.44
|
|
|
29,031
|
|
|
106.05
|
|
|
31,656
|
|
|
33,138
|
|
|
104.68
|
|
|
33,226
|
|
|
104.96
|
|
Reverse mortgages
|
53,330
|
|
|
58,256
|
|
|
109.24
|
|
|
58,567
|
|
|
109.82
|
|
|
57,411
|
|
|
62,058
|
|
|
108.09
|
|
|
63,114
|
|
|
109.93
|
|
Total Agency RMBS
|
1,537,248
|
|
|
1,621,517
|
|
|
105.48
|
|
|
1,629,243
|
|
|
105.98
|
|
|
1,130,360
|
|
|
1,195,201
|
|
|
105.74
|
|
|
1,204,645
|
|
|
106.57
|
|
Non-Agency RMBS
|
24,977
|
|
|
20,630
|
|
|
82.60
|
|
|
18,122
|
|
|
72.55
|
|
|
27,794
|
|
|
19,446
|
|
|
69.96
|
|
|
18,268
|
|
|
65.73
|
|
Total RMBS
(2)
|
1,562,225
|
|
|
1,642,147
|
|
|
105.12
|
|
|
1,647,365
|
|
|
105.45
|
|
|
1,158,154
|
|
|
1,214,647
|
|
|
104.88
|
|
|
1,222,913
|
|
|
105.59
|
|
Agency IOs
|
n/a
|
|
10,882
|
|
|
n/a
|
|
11,395
|
|
|
n/a
|
|
n/a
|
|
12,347
|
|
|
n/a
|
|
11,841
|
|
|
n/a
|
Total mortgage-backed securities
|
|
|
1,653,029
|
|
|
|
|
1,658,760
|
|
|
|
|
|
|
1,226,994
|
|
|
|
|
1,234,754
|
|
|
|
U.S. Treasury securities sold short
|
(74,788)
|
|
(72,762
|
)
|
|
97.29
|
|
|
(73,793
|
)
|
|
98.67
|
|
|
(78,589)
|
|
(74,194
|
)
|
|
94.41
|
|
|
(75,465
|
)
|
|
96.02
|
|
Reverse repurchase agreements
|
73,470
|
|
73,470
|
|
|
100.00
|
|
|
73,470
|
|
|
100.00
|
|
|
75,012
|
|
75,012
|
|
|
100.00
|
|
|
75,012
|
|
|
100.00
|
|
Total
|
|
|
$
|
1,653,737
|
|
|
|
|
$
|
1,658,437
|
|
|
|
|
|
|
$
|
1,227,812
|
|
|
|
|
$
|
1,234,301
|
|
|
|
|
|
(1)
|
Represents the dollar amount (not shown in thousands) per $100 of current principal of the price or cost for the security.
|
The vast majority of our capital is allocated to our Agency RMBS strategy, which includes investments in Agency pools and Agency CMOs. Within this strategy, we generally target Agency RMBS pools that, taking into account their particular composition and based on our prepayment projections: (1) should generate attractive yields relative to other Agency RMBS and U.S. Treasury securities, (2) should have less prepayment sensitivity to government policy shocks and/or (3) should create opportunities for trading gains once the market recognizes their value, which for newer pools may come only after several months when actual prepayment experience can be observed. As of both
June 30, 2017
and December 31, 2016, investments in non-Agency RMBS constituted a relatively small portion of our total investments.
Our most prevalent method of financing RMBS is through short-term repurchase agreements, which generally have maturities of 180 days or less. The weighted average lives of the RMBS that we own are generally much longer. Consequently, the weighted average term of our repurchase agreement financings will almost always be substantially shorter than the expected average maturity of our RMBS. This mismatch in maturities, together with the uncertainty of RMBS prepayments, and other potential changes in timing and/or amount of cash flows on our RMBS assets, creates the risk that changes in interest rates will cause our financing costs with respect to our RMBS to increase relative to the income on our RMBS over the term of our investments.
Financial Derivatives
The following table summarizes our portfolio of financial derivative holdings as of
June 30, 2017
and December 31, 2016:
|
|
|
|
|
|
|
|
|
|
(In thousands)
|
|
June 30, 2017
|
|
December 31, 2016
|
Financial derivatives–assets, at fair value:
|
|
|
|
|
TBA securities purchase contracts
|
|
$
|
—
|
|
|
$
|
96
|
|
TBA securities sale contracts
|
|
1,936
|
|
|
949
|
|
Fixed payer interest rate swaps
|
|
3,294
|
|
|
4,198
|
|
Fixed receiver interest rate swaps
|
|
710
|
|
|
693
|
|
Futures
|
|
166
|
|
|
72
|
|
Total financial derivatives–assets, at fair value
|
|
6,106
|
|
|
6,008
|
|
Financial derivatives–liabilities, at fair value:
|
|
|
|
|
TBA securities purchase contracts
|
|
(328
|
)
|
|
—
|
|
TBA securities sale contracts
|
|
(1
|
)
|
|
(554
|
)
|
Fixed payer interest rate swaps
|
|
(2,357
|
)
|
|
(1,421
|
)
|
Total financial derivatives–liabilities, at fair value
|
|
(2,686
|
)
|
|
(1,975
|
)
|
Total
|
|
$
|
3,420
|
|
|
$
|
4,033
|
|
Pursuant to our hedging program, we engage in a variety of interest rate hedging activities that are designed to reduce the interest rate risk with respect to the liabilities incurred to acquire or hold RMBS. These interest rate hedges generally seek to reduce the interest rate sensitivity of our liabilities or, in other words, reduce the volatility of our financing cost over time attributable to interest rate changes. Our interest rate hedging transactions may include:
•
Interest rate swaps (a contract exchanging a variable rate for a fixed rate, or vice versa);
•
Interest rate swaptions (options to enter into interest rate swaps at a future date);
•
TBA forward contracts on Agency pass-through certificates;
•
Short sales of U.S. Treasury securities;
•
Eurodollar and U.S. Treasury futures; and
•
Other derivatives.
We generally enter into these transactions to offset the potential adverse effects of rising interest rates on short-term repurchase agreements. Our repurchase agreements generally have maturities of up to 180 days and carry interest rates that are determined by reference to LIBOR or correlated benchmark rates for those same periods. As each then-existing fixed-rate repo borrowing matures, it will generally be replaced with a new fixed-rate repo borrowing based on market interest rates established at that future date.
In the case of interest rate swaps, most of our agreements are structured such that we receive payments based on a variable interest rate and make payments based on a fixed interest rate. The variable interest rate on which payments are received is generally calculated based on various reset mechanisms for LIBOR. To the extent that our future repo borrowing costs continue to be highly correlated with LIBOR, our swap agreements help to reduce the variability of our overall repo borrowing costs, thus reducing risk to the extent we hold fixed-rate assets that are financed with repo borrowings.
In the case of TBAs, most of our positions are short TBA positions with a negative duration, meaning that as interest rates rise, the value of the short position increases, so these positions serve as a hedge against increases in interest rates. In the event that interest rates rise, the increase in value of the short TBA position serves to offset corollary increases in our current and/or future borrowing costs under our repurchase agreements. While we primarily use TBAs to hedge interest rate risk, from time to time we also hold net long positions in certain TBA securities as a means of acquiring exposure to Agency RMBS. Our ability to engage in TBA transactions may be limited by our intention to remain qualified as a REIT.
As of
June 30, 2017
, as part of our interest rate hedging program, we also held short positions in U.S. Treasury securities, with a total principal amount of
$74.8 million
and a fair value of
$72.8 million
. As of December 31, 2016, we also held short positions in U.S. Treasury securities, with a total principal amount of
$78.6 million
and a fair value of
$74.2 million
.
The composition and relative mix of our hedging instruments may vary from period to period given the amount of our liabilities outstanding or anticipated to be entered into, the overall market environment and our view as to which instruments best enable us to execute our hedging goals.
Leverage
The following table summarizes our outstanding liabilities under repurchase agreements as of
June 30, 2017
and December 31, 2016. We had no other borrowings outstanding.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2017
|
|
December 31, 2016
|
|
|
|
|
Weighted Average
|
|
|
|
Weighted Average
|
Remaining Days to Maturity
|
|
Borrowings Outstanding
|
|
Interest Rate
|
|
Remaining Days to Maturity
|
|
Borrowings Outstanding
|
|
Interest Rate
|
|
Remaining Days to Maturity
|
|
|
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
30 days or less
|
|
$
|
688,807
|
|
|
1.21
|
%
|
|
15
|
|
|
$
|
545,817
|
|
|
0.80
|
%
|
|
19
|
31-60 days
|
|
707,251
|
|
|
1.22
|
|
|
47
|
|
|
304,398
|
|
|
0.91
|
|
|
45
|
61-90 days
|
|
205,465
|
|
|
1.33
|
|
|
77
|
|
|
299,081
|
|
|
0.98
|
|
|
74
|
91-120 days
|
|
16,927
|
|
|
1.17
|
|
|
105
|
|
|
1,050
|
|
|
0.88
|
|
|
109
|
121-150 days
|
|
—
|
|
|
—
|
|
|
—
|
|
|
12,428
|
|
|
0.97
|
|
|
135
|
151-180 days
|
|
10,000
|
|
|
1.45
|
|
|
171
|
|
|
35,199
|
|
|
1.05
|
|
|
164
|
Total
|
|
$
|
1,628,450
|
|
|
1.23
|
%
|
|
39
|
|
|
$
|
1,197,973
|
|
|
0.88
|
%
|
|
45
|
We finance our assets with what we believe to be a prudent amount of leverage, which will vary from time to time based upon the particular characteristics of our portfolio, availability of financing, and market conditions. Because our strategy is flexible, dynamic, and opportunistic, our overall leverage will vary over time. As of
June 30, 2017
and December 31, 2016, our total debt-to-equity ratio was 9.0 to 1 and 8.5 to 1, respectively. Collateral transferred with respect to our outstanding repo borrowings as of
June 30, 2017
and December 31, 2016 had an aggregate fair value of $1.7 billion and $1.2 billion, respectively. Adjusted for unsettled security purchases and sales, our debt-to-equity ratio was 8.5 to 1 and 8.3 to 1 as of
June 30, 2017
and December 31, 2016, respectively. Our leverage ratio may fluctuate period over period based on portfolio management decisions, market conditions, and the timing of security purchase and sale transactions.
Shareholders' Equity
As of
June 30, 2017
, our shareholders' equity increased to
$181.9 million
from $141.7 million as of December 31, 2016. This increase principally consisted of net proceeds from the issuance of common shares, principally from our May 2017 follow-on common share offering, and subsequent partial exercise of the underwriters' option to purchase additional common shares, of approximately $45.1 million, after offering costs and underwriters' discount, and net income of
$3.7 million
, partially offset by dividends declared of
$8.6 million
. As of
June 30, 2017
, our book value per share was $14.71 as compared to $15.52 as of December 31, 2016. As a result of the total offering, we increased our equity base by approximately 32% and our tradeable float by approximately 52%.
Results of Operations for the Three and Six Month Periods Ended
June 30, 2017
and 2016
The following table summarizes our results of operations for the three and six month periods ended
June 30, 2017
and 2016:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(In thousands except for per share amounts)
|
|
Three Month Period Ended
June 30, 2017
|
|
Three Month Period Ended
June 30, 2016
|
|
Six Month Period Ended
June 30, 2017
|
|
Six Month Period Ended
June 30, 2016
|
Net Interest Income
|
|
|
|
|
|
|
|
|
Net interest income
|
|
$
|
6,863
|
|
|
$
|
5,278
|
|
|
$
|
16,012
|
|
|
$
|
12,878
|
|
Expenses
|
|
|
|
|
|
|
|
|
Management fees
|
|
685
|
|
|
528
|
|
|
1,212
|
|
|
1,056
|
|
Other operating expenses
|
|
752
|
|
|
744
|
|
|
1,497
|
|
|
1,566
|
|
Total expenses
|
|
1,437
|
|
|
1,272
|
|
|
2,709
|
|
|
2,622
|
|
Other Income (Loss)
|
|
|
|
|
|
|
|
|
Net realized and change in net unrealized gains (losses) on securities
|
|
3,777
|
|
|
7,979
|
|
|
(1,561
|
)
|
|
19,623
|
|
Net realized and change in net unrealized gains (losses) on financial derivatives
|
|
(7,600
|
)
|
|
(8,478
|
)
|
|
(8,087
|
)
|
|
(26,610
|
)
|
Total Other Income (Loss)
|
|
(3,823
|
)
|
|
(499
|
)
|
|
(9,648
|
)
|
|
(6,987
|
)
|
Net Income
|
|
$
|
1,603
|
|
|
$
|
3,507
|
|
|
$
|
3,655
|
|
|
$
|
3,269
|
|
Net Income Per Common Share
|
|
$
|
0.15
|
|
|
$
|
0.38
|
|
|
$
|
0.37
|
|
|
$
|
0.36
|
|
Core Earnings
Core Earnings consists of net income (loss), excluding realized and change in net unrealized gains and (losses) on securities and financial derivatives, and, if applicable, items of income or loss that are of a non-recurring nature. Core Earnings includes net realized and change in net unrealized gains (losses) associated with payments and accruals of periodic payments on interest rate swaps. Our interest income is subject to fluctuations based on adjustments to premium amortization as a result of changes in prepayments of our Agency RMBS (accompanied by a corresponding offsetting adjustment to realized and unrealized gains and losses). We refer to this adjustment as a "Catch-up Premium Amortization Adjustment." Adjusted Core Earnings represents Core Earnings excluding the effect of the Catch-up Premium Amortization Adjustment on interest income. Core Earnings and Adjusted Core Earnings are supplemental non-GAAP financial measures. We believe that Core Earnings and Adjusted Core Earnings provide information useful to investors because they are metrics that we use to assess our performance and to evaluate the effective net yield provided by the portfolio. Moreover, one of our objectives is to generate income from the net interest margin on the portfolio, and Core Earnings and Adjusted Core Earnings are used to help measure the extent to which this objective is being achieved. However, because Core Earnings and Adjusted Core Earnings are incomplete measures of our financial results and differ from net income (loss) computed in accordance with U.S. GAAP, they should be considered as supplementary to, and not as substitutes for, net income (loss) computed in accordance with U.S. GAAP.
The table below reconciles Core Earnings and Adjusted Core Earnings for the three and six month periods ended
June 30, 2017
and 2016 to the line, Net Income, on our Consolidated Statement of Operations, which we believe is the most directly comparable U.S. GAAP measure:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(In thousands except for share amounts)
|
|
Three Month Period Ended
June 30, 2017
|
|
Three Month Period Ended
June 30, 2016
|
|
Six Month Period Ended
June 30, 2017
|
|
Six Month Period Ended
June 30, 2016
|
Net Income
|
|
$
|
1,603
|
|
|
$
|
3,507
|
|
|
$
|
3,655
|
|
|
$
|
3,269
|
|
Less:
|
|
|
|
|
|
|
|
|
Net realized gains (losses) on securities
|
|
(359
|
)
|
|
2,100
|
|
|
(3,350
|
)
|
|
5,111
|
|
Net realized losses on financial derivatives, excluding periodic payments
(1)
|
|
(8,192
|
)
|
|
(11,099
|
)
|
|
(6,523
|
)
|
|
(14,423
|
)
|
Change in net unrealized gains (losses) on securities
|
|
4,136
|
|
|
5,879
|
|
|
1,789
|
|
|
14,512
|
|
Change in net unrealized gains (losses) on financial derivatives, excluding accrued periodic payments
(2)
|
|
1,211
|
|
|
3,681
|
|
|
(469
|
)
|
|
(9,729
|
)
|
Subtotal
|
|
(3,204
|
)
|
|
561
|
|
|
(8,553
|
)
|
|
(4,529
|
)
|
Core Earnings
|
|
$
|
4,807
|
|
|
$
|
2,946
|
|
|
$
|
12,208
|
|
|
$
|
7,798
|
|
Catch-up Premium Amortization Adjustment
|
|
(274
|
)
|
|
(1,457
|
)
|
|
2,310
|
|
|
(1,200
|
)
|
Adjusted Core Earnings
|
|
5,081
|
|
|
4,403
|
|
|
9,898
|
|
|
8,998
|
|
Weighted Average Shares Outstanding
|
|
10,741,074
|
|
|
9,117,183
|
|
|
9,940,433
|
|
|
9,119,190
|
|
Core Earnings Per Share
|
|
$
|
0.45
|
|
|
$
|
0.32
|
|
|
$
|
1.23
|
|
|
$
|
0.86
|
|
Adjusted Core Earnings Per Share
|
|
$
|
0.47
|
|
|
$
|
0.48
|
|
|
$
|
1.00
|
|
|
$
|
0.99
|
|
|
|
(1)
|
For the three month period ended
June 30, 2017
, represents Net realized gains (losses) on financial derivatives of
$(9,128)
less Net realized gains (losses) on periodic settlements of interest rate swaps of
$(936)
. For the three month period ended
June 30, 2016
, represents Net realized gains (losses) on financial derivatives of
$(13,607)
less Net realized gains (losses) on periodic settlements of interest rate swaps of
$(2,508)
. For the six month period ended
June 30, 2017
, represents Net realized gains (losses) on financial derivatives of
$(7,474)
less Net realized gains (losses) on periodic settlements of interest rate swaps of
$(951)
. For the six month period ended
June 30, 2016
, represents Net realized gains (losses) on financial derivatives of
$(17,603)
less Net realized gains (losses) on periodic settlements of interest rate swaps of
$(3,180)
.
|
|
|
(2)
|
For the three month period ended
June 30, 2017
, represents Change in net unrealized gains (losses) on financial derivatives of
$1,528
less Change in net unrealized gains (losses) on accrued periodic settlements of interest rate swaps of
$317
. For the three month period ended
June 30, 2016
, represents Change in net unrealized gains (losses) on financial derivatives of
$5,129
less Change in net unrealized gains (losses) on accrued periodic settlements of interest rate swaps of
$1,448
. For the six month period ended
June 30, 2017
, represents Change in net unrealized gains (losses) on financial derivatives of
$(613)
less Change in net unrealized gains (losses) on accrued periodic settlements of interest rate swaps of
$(144)
. For the six month period ended
June 30, 2016
, represents Change in net unrealized gains (losses) on financial derivatives of
$(9,007)
less Change in net unrealized gains (losses) on accrued periodic settlements of interest rate swaps of
$722
.
|
Results of Operations for the Three Month Periods Ended
June 30, 2017
and 2016
Net Income (Loss)
The decrease in net income for the three month period ended
June 30, 2017
as compared to the three month period ended
June 30, 2016
was principally due to an increase in combined net realized and unrealized losses on securities and financial derivatives, or Total Other Income (Loss), for the three month period ended
June 30, 2017
. Higher interest income on a larger portfolio during the three month period ended June 30, 2017 partially offset the period-over-period increase in Total Other Loss. During the three month period ended June 30, 2017, lower interest rates led to losses on our interest rate hedges, while market anticipation around the eventual tapering of purchases of Agency RMBS by the Federal Reserve restrained price increases of Agency RMBS.
Interest Income
Our portfolio as of each of
June 30, 2017
and 2016 consisted primarily of Agency RMBS, and to a lesser extent, non-Agency RMBS. Before interest expense, we earned approximately
$10.7 million
and
$7.4 million
in interest income on these securities for the three month periods ended
June 30, 2017
and 2016, respectively. The period-over-period increase in interest income resulted from higher average holdings and higher weighted average yield on our Agency RMBS. Some of the variability in our interest income and portfolio yields is due to Catch-up Premium Amortization Adjustment. The adjustment is calculated as of the beginning of each quarter based on our then assumptions about cashflows and prepayments, and can vary significantly from quarter to quarter. For the second quarter of 2017, we had a negative Catch-up Premium Amortization Adjustment of approximately $0.3 million, which decreased our interest income. Excluding the Catch-up Premium Amortization Adjustment, the weighted average yield of our portfolio was 3.01% for the second quarter of 2017. By comparison, for the second quarter of 2016 the Catch-up Premium Amortization Adjustment decreased interest income by approximately $1.5 million. Excluding this
Catch-up Premium Amortization Adjustment, the weighted average yield on our portfolio for the second quarter of 2016 would have been 2.94%.
The following table details our interest income, average holdings of yield-bearing assets, and weighted average yield based on amortized cost for the three month periods ended
June 30, 2017
and 2016:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-Agency
(1)
|
|
Agency
(1)
|
|
Total
(1)
|
(In thousands)
|
Interest Income
|
|
Average Holdings
|
|
Yield
|
|
Interest Income
|
|
Average Holdings
|
|
Yield
|
|
Interest Income
|
|
Average Holdings
|
|
Yield
|
Three month period ended June 30, 2017
|
$
|
326
|
|
|
$
|
16,258
|
|
|
8.02
|
%
|
|
$
|
10,332
|
|
|
$
|
1,435,494
|
|
|
2.88
|
%
|
|
$
|
10,658
|
|
|
$
|
1,451,752
|
|
|
2.94
|
%
|
Three month period ended June 30, 2016
|
$
|
650
|
|
|
$
|
23,590
|
|
|
11.00
|
%
|
|
$
|
6,794
|
|
|
$
|
1,187,831
|
|
|
2.29
|
%
|
|
$
|
7,444
|
|
|
$
|
1,211,421
|
|
|
2.45
|
%
|
|
|
(1)
|
Amounts exclude interest income on cash and cash equivalents (including when posted as margin) and long U.S. Treasury securities.
|
Interest Expense
For each of the three month periods ended
June 30, 2017
and 2016, the majority of interest expense that we incurred was related to our repo borrowings, which we use to finance our assets. We also incur interest expense in connection with our short positions in U.S. Treasury securities. Our total interest expense for the three month period ended
June 30, 2017
was
$4.0 million
, of which
$3.6 million
represented interest expense on our repo and approximately $0.4 million represented interest expense related primarily to our short positions in U.S. Treasury securities. Our total interest expense for the three month period ended
June 30, 2016
was
$2.3 million
, of which
$2.0 million
represented interest expense on our repo borrowings and approximately $0.3 million represented interest expense related primarily to our short positions in U.S. Treasury securities. The period-over-period increase in our total interest expense resulted mainly from higher rates on our repo borrowings as well as an increase in average borrowings. Our average outstanding repo borrowings for the three month period ended
June 30, 2017
was
$1.3 billion
, resulting in an average cost of funds of
1.09%
. Our average outstanding repo borrowings for the three month period ended
June 30, 2016
was
$1.1 billion
, resulting in an average cost of funds of
0.70%
.
The following table shows information related to our average cost of funds for the three month periods ended
June 30, 2017
and 2016.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
($ in thousands)
|
|
Average Borrowed Funds
|
|
Interest Expense
|
|
Average Cost of Funds
|
|
Average One-Month LIBOR
|
|
Average Six-Month LIBOR
|
Three Month Period Ended June 30, 2017
|
|
$
|
1,339,806
|
|
|
$
|
3,632
|
|
|
1.09
|
%
|
|
1.06
|
%
|
|
1.42
|
%
|
Three Month Period Ended June 30, 2016
|
|
$
|
1,132,184
|
|
|
$
|
1,969
|
|
|
0.70
|
%
|
|
0.44
|
%
|
|
0.92
|
%
|
As an alternative cost of funds measure, we add to our repo borrowing cost the net periodic amounts paid or payable by us on our interest rate swaps and the interest expense we incur on our short positions in U.S. Treasury securities, and express the total as an annualized percentage of our average outstanding borrowings. The total of our net periodic expense paid or payable under our interest rate swaps and our interest expense on our short positions in U.S. Treasury securities was $1.0 million for the three month period ended
June 30, 2017
, or 0.30% of our average outstanding repo borrowings, on an annualized basis, thereby resulting in an average cost of funds including interest rate swaps and short positions in U.S. Treasury securities of 1.38%. The total of our net periodic expense paid or payable under our interest rate swaps was $1.3 million for the three month period ended
June 30, 2016
, or 0.47% of our average outstanding borrowings, on an annualized basis, thereby resulting in an average cost of funds including interest rate swaps and short positions in U.S. Treasury securities of 1.17%. This metric does not take into account other instruments that we use to hedge interest rate risk, such as TBAs, swaptions, and futures.
Management Fees
For the three month periods ended
June 30, 2017
and 2016, our management fee expense was approximately
$0.7 million
and
$0.5 million
, respectively. The period-over-period increase was due to a higher capital base resulting from our follow-on equity offering that occurred during the three month period ended June 30, 2017. Management fees are calculated based on our shareholders' equity at the end of the quarter.
Other Operating Expenses
Other operating expenses, as presented above, include professional fees, compensation expense, and various other expenses incurred in connection with the operation of our business. Other operating expenses for the three month periods ended
June 30, 2017
and 2016 were approximately
$0.8 million
and
$0.7 million
, respectively. Our expense ratio, which represents our management fees and other operating expenses as a percentage of our average shareholders' equity, was 3.6% for each of the three month periods ended
June 30, 2017
and 2016.
Other Income (Loss)
Other income (loss) consists of net realized and net change in unrealized gain (losses) on securities and financial derivatives. For the three month period ended
June 30, 2017
, other loss was
$(3.8) million
, and consisted of net realized and change in net unrealized losses of
$(7.6) million
on our financial derivatives partially offset by net realized and change in net unrealized gains of
$3.8 million
on our securities, primarily our Agency RMBS. The three month period ended
June 30, 2017
included modest increases in asset valuations, mainly on our Agency RMBS, as prices of fixed-rate Agency RMBS generally increased and pay-ups on specified pools increased slightly. Our interest rate hedges, which primarily include interest rate swaps and short positions in TBAs and U.S. Treasury securities, generated net losses during the three month period ended June 30, 2017. Declining longer-term interest rates led to losses on our interest rate swaps and U.S. Treasury securities while firm dollar roll prices led to net losses on our TBA hedges. Because we use short TBAs as a major component of our interest rate hedging portfolio, the relative underperformance of specified pools in comparison to TBAs dampened our results for the second quarter.
Other income (loss) for the three month period ended
June 30, 2016
was
$(0.5) million
and consisted of net realized and change in net unrealized losses of
$(8.5) million
on our financial derivatives partially offset by net realized and change in net unrealized gains of approximately
$8.0 million
on our securities, primarily our Agency RMBS. Sharply lower interest rates during the period led to losses on our interest rate hedges. Additionally, demand for Agency RMBS increased over the quarter, providing support to prices and yield spreads.
Results of Operations for the Six Month Periods Ended
June 30, 2017
and 2016
Net Income (Loss)
There was a slight increase in net income for the six month period ended
June 30, 2017
as compared to the six month period ended
June 30, 2016
. Net income for the six month period ended June 30, 2017 relative to the prior six month period included an increase in net interest income as well as an increase in total net losses included in Total Other Income (Loss), which includes net realized and unrealized gains and losses on securities and financial derivatives. A larger, higher-yielding Agency portfolio led to the increase in net interest income for the six month period ended
June 30, 2017
while relative underperformance of specified pools compared to TBA hedges weighed on Total Other Loss. The six month period ended June 30, 2016 was marked by periods of significant volatility in interest rates which led to net realized and unrealized losses on our financial derivatives. For the six month period ended June 30, 2017, interest rate volatility was significantly lower as compared to the same period of 2016.
Interest Income
Our portfolio as of each of
June 30, 2017
and 2016 consisted primarily of Agency RMBS, and to a lesser extent, non-Agency RMBS. Before interest expense, we earned approximately
$22.8 million
and
$17.0 million
in interest income on these securities for the six month periods ended
June 30, 2017
and 2016, respectively. The period-over-period increase in interest income resulted from higher average holdings and higher weighted average yields on our Agency RMBS. Some of the variability in our interest income and portfolio yields is due to Catch-up Premium Amortization Adjustment. For the six month period ended June 30, 2017, we had a positive Catch-up Premium Amortization Adjustment of approximately $2.3 million, which increased our interest income. Excluding the Catch-up Premium Amortization Adjustment, the weighted average yield of our portfolio was 3.00% for the six month period ended June 30, 2017. By comparison, for the six month period ended June 30, 2016 the Catch-up Premium Amortization Adjustment decreased interest income by approximately $1.2 million. Excluding this Catch-up Premium Amortization Adjustment, the weighted average yield on our portfolio for the six month period ended June 30, 2016 would have been 2.99%.
The following table details our interest income, average holdings of yield-bearing assets, and weighted average yield based on amortized cost for the six month periods ended
June 30, 2017
and 2016:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-Agency
(1)
|
|
Agency
(1)
|
|
Total
(1)
|
(In thousands)
|
Interest Income
|
|
Average Holdings
|
|
Yield
|
|
Interest Income
|
|
Average Holdings
|
|
Yield
|
|
Interest Income
|
|
Average Holdings
|
|
Yield
|
Six month period ended June 30, 2017
|
$
|
680
|
|
|
$
|
16,085
|
|
|
8.45
|
%
|
|
$
|
22,156
|
|
|
$
|
1,351,635
|
|
|
3.28
|
%
|
|
$
|
22,836
|
|
|
$
|
1,367,720
|
|
|
3.34
|
%
|
Six month period ended June 30, 2016
|
$
|
1,269
|
|
|
$
|
26,049
|
|
|
9.74
|
%
|
|
$
|
15,744
|
|
|
$
|
1,192,770
|
|
|
2.64
|
%
|
|
$
|
17,013
|
|
|
$
|
1,218,819
|
|
|
2.79
|
%
|
|
|
(1)
|
Amounts exclude interest income on cash and cash equivalents (including when posted as margin) and long U.S. Treasury securities.
|
Interest Expense
For the six month periods ended
June 30, 2017
and 2016, the majority of interest expense that we incurred was related to our repo borrowings, which we use to finance our assets. We also incur interest expense in connection with our short positions in U.S. Treasury securities. Our total interest expense for the six month period ended
June 30, 2017
was
$7.2 million
, of which
$6.4 million
represented interest expense on our repo and approximately $0.8 million represented interest expense related primarily to our short positions in U.S. Treasury securities. Our total interest expense for the six month period ended
June 30, 2016
was
$4.3 million
, of which
$3.7 million
represented interest expense on our repo borrowings and approximately $0.6 million represented interest expense related primarily to our short positions in U.S. Treasury securities. The period-over-period increase in our total interest expense resulted mainly from higher rates on our repo borrowings as well as an increase in average borrowings. Our average outstanding repo borrowings for the six month period ended
June 30, 2017
was
$1.27 billion
, resulting in an average cost of funds of
1.02%
. Our average outstanding repo borrowings for the six month period ended
June 30, 2016
was
$1.14 billion
, resulting in an average cost of funds of
0.66%
.
The following table shows information related to our average cost of funds for the six month periods ended
June 30, 2017
and 2016.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
($ in thousands)
|
|
Average Borrowed Funds
|
|
Interest Expense
|
|
Average Cost of Funds
|
|
Average One-Month LIBOR
|
|
Average Six-Month LIBOR
|
Six Month Period Ended June 30, 2017
|
|
$
|
1,267,465
|
|
|
$
|
6,415
|
|
|
1.02
|
%
|
|
0.94
|
%
|
|
1.40
|
%
|
Six Month Period Ended June 30, 2016
|
|
$
|
1,137,343
|
|
|
$
|
3,732
|
|
|
0.66
|
%
|
|
0.44
|
%
|
|
0.90
|
%
|
As an alternative cost of funds measure, we add to our repo borrowing cost the net periodic amounts paid or payable by us on our interest rate swaps and the interest expense we incur on our short positions in U.S. Treasury securities, and express the total as an annualized percentage of our average outstanding borrowings. The total of our net periodic expense paid or payable under our interest rate swaps and our interest expense on our short positions in U.S. Treasury securities was $1.8 million for the six month period ended
June 30, 2017
, or 0.29% of our average outstanding repo borrowings, on an annualized basis, thereby resulting in an average cost of funds including interest rate swaps and short positions in U.S. Treasury securities of 1.31%. The total of our net periodic expense paid or payable under our interest rate swaps was $3.0 million for the six month period ended
June 30, 2016
, or 0.53% of our average outstanding borrowings, on an annualized basis, thereby resulting in an average cost of funds including interest rate swaps and short positions in U.S. Treasury securities of 1.19%. This metric does not take into account other instruments that we use to hedge interest rate risk, such as TBAs, swaptions, and futures.
Management Fees
For the six month periods ended
June 30, 2017
and 2016, our management fee expense was approximately
$1.2 million
and
$1.1 million
, respectively. The slight period-over-period increase was due to a higher capital base resulting from our follow-on equity offering, completed during the six month period ended June 30, 2017. Management fees are calculated based on our shareholders' equity at the end of each quarter.
Other Operating Expenses
Other operating expenses, as presented above, include professional fees, compensation expense, and various other expenses incurred in connection with the operation of our business. Other operating expenses for the six month periods ended
June 30, 2017
and 2016 were approximately
$1.5 million
and
$1.6 million
, respectively. Our expense ratio, which represents our management fees and other operating expenses as a percentage of our average shareholders' equity, was 3.6% for the six
month period ended
June 30, 2017
, as compared to 3.7% for the six month period ended
June 30, 2016
. The decrease in our expense ratio was primarily due to an increase in average shareholders' equity as well as a decrease in administration and professional fees for the six month period ended
June 30, 2017
as compared to the six month period ended
June 30, 2016
.
Other Income (Loss)
Other income (loss) consists of net realized and net change in unrealized gain (losses) on securities and financial derivatives. For the six month period ended
June 30, 2017
, other loss was
$(9.6) million
, and consisted of net realized and change in net unrealized losses of
$(8.1) million
on our financial derivatives and approximately
$(1.6) million
on our securities, primarily our Agency RMBS. During the six month period ended
June 30, 2017
fixed-income credit spreads generally tightened. However, Agency RMBS slightly underperformed other fixed-income sectors on market concerns around the eventual tapering of Agency RMBS purchases by the Federal Reserve. We had net losses on our interest rate hedges as longer-term interest rates decreased over the period. For the six month period ended
June 30, 2017
, as measured by sales and excluding paydowns, we turned over approximately 71% of our Agency RMBS portfolio and, as a result, we generated net realized losses of $(2.5) million on our Agency RMBS portfolio. Our interest rate hedges, which primarily include interest rate swaps, short positions in TBAs and U.S. Treasury securities, generated net losses during the six month period ended June 30, 2017. Declining longer-term interest rates led to losses on our interest rate swaps and U.S. Treasury securities while firm dollar roll prices led to net losses on our TBA hedges. Because we use short TBAs as a major component of our interest rate hedging portfolio, the relative underperformance of specified pools in comparison to TBAs dampened our overall results for the period.
Other income (loss) for the six month period ended
June 30, 2016
was
$(7.0) million
and consisted of net realized and change in net unrealized losses of
$(26.6) million
on our financial derivatives partially offset by net realized and change in net unrealized gains of approximately
$19.6 million
on our securities, primarily our Agency RMBS. Overall, interest rates declined over the course of the six month period which was marked by significant interest rate volatility, and both prices and pay-ups on our specified Agency pools increased.
Liquidity and Capital Resources
Liquidity refers to our ability to meet our cash needs, including repaying our borrowings, funding and maintaining RMBS and other assets, paying dividends, and other general business needs. Our short-term (one year or less) and long-term liquidity requirements include acquisition costs for assets we acquire, payment of our management fee, compliance with margin requirements under our repurchase agreements, TBA and other financial derivative contracts, repayment of repurchase agreement borrowings to the extent we are unable or unwilling to extend our repurchase agreements, the payment of dividends, and payment of our general operating expenses. Our capital resources primarily include cash on hand, cash flow from our investments (including monthly principal and interest payments received on our RMBS and proceeds from the sale of RMBS), borrowings under repurchase agreements, and proceeds from equity offerings. We expect that these sources of funds will be sufficient to meet our short-term and long-term liquidity needs.
We borrow funds in the form of repurchase agreements. The terms of our repo borrowings are predominantly governed by Master Repurchase Agreements, or "MRAs," which generally conform to the terms in the standard master repurchase agreement as published by the Securities Industry and Financial Markets Association as to repayment and margin requirements. In addition, each lender may require that we include supplemental terms and conditions to the standard master repurchase agreement. Typical supplemental terms and conditions include the addition of or changes to provisions relating to margin calls, net asset value requirements, cross default provisions, certain key person events, changes in corporate structure, and requirements that all controversies related to the repurchase agreement be litigated in a particular jurisdiction. These provisions may differ for each of our lenders.
As of
June 30, 2017
and December 31, 2016, we had
$1.6 billion
and $1.2 billion, respectively, outstanding under our repurchase agreements. As of
June 30, 2017
, our outstanding repurchase agreements were with
thirteen
counterparties.
Amount at risk represents the excess, if any, for each counterparty of the fair value of collateral held by such counterparty over the amounts outstanding under repurchase agreements. The following table reflects counterparties for which the amounts at risk relating to our repurchase agreements was greater than 5% of shareholders' equity as of
June 30, 2017
and December 31, 2016.
June 30, 2017
:
|
|
|
|
|
|
|
|
|
|
|
Counterparty
|
|
Amount at Risk
(1)
|
|
Weighted Average Remaining Days to Maturity
|
|
Percentage of Shareholders' Equity
|
|
|
(In thousands)
|
|
|
|
|
J.P. Morgan Securities Inc.
|
|
$
|
19,365
|
|
|
38
|
|
10.6
|
%
|
RBC Capital Markets LLC
|
|
14,060
|
|
|
45
|
|
7.7
|
%
|
Wells Fargo Bank, N.A.
|
|
12,175
|
|
|
32
|
|
6.7
|
%
|
Deutsche Bank Securities
|
|
11,952
|
|
|
25
|
|
6.6
|
%
|
|
|
(1)
|
Amounts at risk exclude, in aggregate, $2.0 million of net accrued interest, defined as accrued interest on securities held as collateral less interest payable on cash borrowed.
|
December 31, 2016:
|
|
|
|
|
|
|
|
|
|
|
Counterparty
|
|
Amount at Risk
(1)
|
|
Weighted Average Remaining Days to Maturity
|
|
Percentage of Shareholders' Equity
|
|
|
(In thousands)
|
|
|
|
|
J.P. Morgan Securities Inc.
|
|
$
|
15,077
|
|
|
58
|
|
10.6
|
%
|
Deutsche Bank Securities
|
|
11,778
|
|
|
36
|
|
8.3
|
%
|
Wells Fargo Bank, N.A.
|
|
11,533
|
|
|
38
|
|
8.1
|
%
|
RBC Capital Markets LLC
|
|
11,506
|
|
|
34
|
|
8.1
|
%
|
|
|
(1)
|
Amounts at risk exclude, in aggregate, $1.6 million of net accrued interest, defined as accrued interest on securities held as collateral less interest payable on cash borrowed.
|
The amounts borrowed under our repurchase agreements are generally subject to the application of "haircuts." A haircut is the percentage discount that a repo lender applies to the market value of an asset serving as collateral for a repo borrowing, for the purpose of determining whether such repo borrowing is adequately collateralized. As of
June 30, 2017
and December 31, 2016, the weighted average contractual haircut applicable to the assets that serve as collateral for our outstanding repo borrowings was 4.9% and 4.8%, respectively.
The following table details total outstanding borrowings, average outstanding borrowings, and the maximum outstanding borrowings at any month end for each quarter under repurchase agreements for the past twelve quarters.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended
|
|
Borrowings
Outstanding at
Quarter End
|
|
Average
Borrowings Outstanding
|
|
Maximum Borrowings Outstanding at Any Month End
|
|
|
(In thousands)
|
June 30, 2017
(1)
|
|
$
|
1,628,450
|
|
|
$
|
1,339,806
|
|
|
$
|
1,628,450
|
|
March 31, 2017
|
|
1,178,285
|
|
|
1,194,321
|
|
|
1,199,860
|
|
December 31, 2016
|
|
1,197,973
|
|
|
1,170,091
|
|
|
1,197,973
|
|
September 30, 2016
|
|
1,158,962
|
|
|
1,138,439
|
|
|
1,158,962
|
|
June 30, 2016
|
|
1,205,987
|
|
|
1,132,184
|
|
|
1,205,987
|
|
March 31, 2016
|
|
1,133,841
|
|
|
1,142,501
|
|
|
1,175,531
|
|
December 31, 2015
|
|
1,222,719
|
|
|
1,228,964
|
|
|
1,286,274
|
|
September 30, 2015
|
|
1,225,905
|
|
|
1,242,650
|
|
|
1,248,604
|
|
June 30, 2015
|
|
1,264,479
|
|
|
1,247,617
|
|
|
1,269,551
|
|
March 31, 2015
|
|
1,211,110
|
|
|
1,239,167
|
|
|
1,255,568
|
|
December 31, 2014
|
|
1,323,080
|
|
|
1,275,874
|
|
|
1,323,080
|
|
September 30, 2014
|
|
1,233,333
|
|
|
1,251,296
|
|
|
1,275,122
|
|
June 30, 2014
|
|
1,285,593
|
|
|
1,239,899
|
|
|
1,285,593
|
|
|
|
(1)
|
For the quarter ended June 30, 2017 the significant increase between average borrowings outstanding and total borrowings as of June 30, 2017 was the result of our deployment of the proceeds from our follow-on offering of common shares during the quarter. Based on our higher equity base, we increased our repo borrowings so as to maintain our desired debt-to-equity ratio.
|
We held cash and cash equivalents of approximately
$41.7 million
and $33.5 million as of
June 30, 2017
and December 31, 2016, respectively.
We may declare dividends based on, among other things, our earnings, our financial condition, the REIT qualification requirements of the Internal Revenue Code of 1986, as amended, our working capital needs and new opportunities. The declaration of dividends to our shareholders and the amount of such dividends are at the discretion of our Board of Trustees. The following table sets forth the dividend distributions authorized by the Board of Trustees for the periods indicated below:
Six Month Period Ended
June 30, 2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dividend
Per Share
|
|
Dividend Amount
|
|
Declaration Date
|
|
Record Date
|
|
Payment Date
|
|
|
|
(In thousands)
|
|
|
|
|
|
|
First Quarter
|
$
|
0.40
|
|
|
$
|
3,652
|
|
|
March 6, 2017
|
|
March 31, 2017
|
|
April 25, 2017
|
Second Quarter
|
$
|
0.40
|
|
|
$
|
4,947
|
|
|
June 13, 2017
|
|
June 30, 2017
|
|
July 25, 2017
|
Six Month Period Ended
June 30, 2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dividend
Per Share
|
|
Dividend Amount
|
|
Declaration Date
|
|
Record Date
|
|
Payment Date
|
|
|
|
(In thousands)
|
|
|
|
|
|
|
First Quarter
|
$
|
0.45
|
|
|
$
|
4,103
|
|
|
March 8, 2016
|
|
March 31, 2016
|
|
April 25, 2016
|
Second Quarter
|
$
|
0.40
|
|
|
$
|
3,647
|
|
|
June 14, 2016
|
|
June 30, 2016
|
|
July 27, 2016
|
For the six month period ended
June 30, 2017
, our operating activities provided net cash of
$30.6 million
and our investing activities used net cash of
$490.7 million
. Our repo activity used to finance our purchase of securities (including repayments, in conjunction with the sales of securities, of amounts borrowed under our repurchase agreements) provided net cash of
$430.5 million
. Thus our operating and investing activities, when combined with our net repo financing activities, used net cash of
$29.6 million
. We received net proceeds from the issuance of common shares of $45.1 million, after underwriters' discounts and offering costs. We used
$7.3 million
to pay dividends. As a result of these activities, there was an increase in our cash holdings of
$8.2 million
from $33.5 million as of December 31, 2016 to
$41.7 million
as of
June 30, 2017
.
For the six month period ended June 30, 2016, our operating activities provided net cash of $21.9 million and our investing activities used net cash of $0.7 million. Our repo activity used to finance our purchase of securities (including repayments, in conjunction with the sales of securities, of amounts borrowed under our repurchase agreements) used net cash of $16.7 million. Thus our operating and investing activities, when combined with our net repo financing activities, provided net cash of $4.4 million for the six month period ended June 30, 2016. We used $8.2 million to pay dividends and $0.2 million for the repurchase of common shares. As a result of these activities, there was a decrease in our cash holdings of $4.0 million from $40.2 million as of December 31, 2015 to $36.2 million as of June 30, 2016.
On August 13, 2013, our Board of Trustees approved the adoption of a $10 million share repurchase program. The program, which is open-ended in duration, allows us to make repurchases from time to time on the open market or in negotiated transactions. Repurchases are at our discretion, subject to applicable law, share availability, price and our financial performance, among other considerations. During the three and six month periods ended
June 30, 2017
, we did not purchase any of our common shares.
In addition to completing an equity offering during the three month period ended June 30, 2017, we also entered into equity distribution agreements for an "at the market" offering program whereby we are able to sell shares from time to time in the open market or in negotiated transactions. Under the program, which is open-ended in duration, we can sell shares with a value of up to $100 million. As of June 30, 2017, we sold 6,738 shares at an average price of $15.12 under the offering program, for net proceeds of $0.1 million after third party agent commissions and fees of $2 thousand.
Based on our current portfolio, amount of free cash on hand, debt-to-equity ratio and current and anticipated availability of credit, we believe that our capital resources will be sufficient to enable us to meet anticipated short-term and long-term liquidity requirements.
We are not required by our investment guidelines to maintain any specific debt-to-equity ratio, and we believe that the appropriate leverage for the particular assets we hold depends on the credit quality and risk of those assets, as well as the general availability and terms of stable and reliable financing for those assets.
Contractual Obligations and Commitments
We are a party to a management agreement with our Manager. Pursuant to that agreement, our Manager is entitled to receive a management fee based on shareholders' equity, reimbursement of certain expenses and, in certain circumstances, a termination fee. Such fees and expenses do not have fixed and determinable payments. For a description of the management agreement provisions, see Note 9 to our consolidated financial statements.
We enter into repurchase agreements with third-party broker-dealers whereby we sell securities to such broker-dealers at agreed-upon purchase prices at the initiation of the repurchase agreements and agree to repurchase such securities at predetermined repurchase prices and termination dates, thus providing the broker-dealers with an implied interest rate on the funds initially transferred to us by the broker-dealers. We may enter into reverse repurchase agreements with third-party broker-dealers whereby we purchase securities under agreements to resell at an agreed-upon price and date. In general, we most often will enter into reverse repurchase agreement transactions in order to effectively borrow securities that we can then deliver to counterparties to whom we have made short sales of the same securities. The implied interest rates on the repurchase agreements and reverse repurchase agreements we enter into are based upon competitive market rates at the time of initiation. Repurchase agreements and reverse repurchase agreements that are conducted with the same counterparty may be reported on a net basis if they meet the requirements of ASC 210-20,
Balance Sheet, Offsetting
. As of
June 30, 2017
and December 31, 2016, there were no repurchase agreements and reverse repurchase agreements reported on a net basis on the Consolidated Balance Sheet.
As of
June 30, 2017
we had
$1.6 billion
of outstanding borrowings with
thirteen
counterparties.
Off-Balance Sheet Arrangements
As of
June 30, 2017
, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Further, we have not guaranteed any obligations of unconsolidated entities nor do we have any commitment or intent to provide funding to any such entities. As such, we are not materially exposed to any market, credit, liquidity, or financing risk that could arise if we had engaged in such relationships.
Inflation
Virtually all of our assets and liabilities are interest rate-sensitive in nature. As a result, interest rates and other factors
influence our performance far more so than does inflation. Changes in interest rates do not necessarily correlate with inflation rates or changes in inflation rates. Our activities and balance sheet are measured with reference to historical cost and/or fair market value without considering inflation.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The primary components of our market risk are related to interest rate risk, prepayment risk, and credit risk. We seek to actively manage these and other risks and to acquire and hold assets that we believe justify bearing those risks, and to maintain capital levels consistent with those risks.
Interest Rate Risk
Interest rates are highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations, and other factors beyond our control. We are subject to interest rate risk in connection with most of our assets and liabilities. For some securities in our portfolio, the coupon interest rates on, and therefore also the values of, such securities are highly sensitive to interest rate movements, such as inverse floating rate RMBS, which benefit from falling interest rates. Our repurchase agreements generally have maturities of up to 180 days and carry interest rates that are determined by reference to LIBOR or similar short-term benchmark rates for those same periods. Whenever one of our fixed-rate repo borrowings matures, it will generally be replaced with a new fixed-rate repo borrowing based on market interest rates prevailing at such time. Subject to qualifying and maintaining our qualification as a REIT and our exclusion from registration under the Investment Company Act, we opportunistically hedge our interest rate risk by entering into interest rate swaps, TBAs, U.S. Treasury securities, Eurodollar and U.S. Treasury futures, and other instruments. In general, such hedging instruments are used to offset the large majority of the interest rate risk we estimate to arise from our repurchase agreement indebtedness generally associated with our Agency RMBS positions. Hedging instruments may also be used to offset a portion of the interest rate risk arising from our repurchase agreement liabilities associated with non-Agency RMBS positions, if any.
In addition to measuring and mitigating the risk related to changes in interest rates with respect to the generally shorter-term liabilities we incur to acquire and hold generally longer-lived RMBS, we also monitor the effect of changes in interest rates on the discounted present value of our portfolio of assets and liabilities. The following sensitivity analysis table shows the estimated impact on the fair value of our portfolio segregated by certain identified categories as of
June 30, 2017
, assuming a static portfolio and immediate and parallel shifts in interest rates from current levels as indicated below.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(In thousands)
|
|
Estimated Change for a Decrease in Interest Rates by
|
|
Estimated Change for an Increase in Interest Rates by
|
|
|
50 Basis Points
|
|
100 Basis Points
|
|
50 Basis Points
|
|
100 Basis Points
|
Category of Instruments
|
|
Market Value
|
|
% of Total Equity
|
|
Market Value
|
|
% of Total Equity
|
|
Market Value
|
|
% of Total Equity
|
|
Market Value
|
|
% of Total Equity
|
Agency RMBS, excluding TBAs
|
|
$
|
24,728
|
|
|
13.59
|
%
|
|
$
|
40,322
|
|
|
22.17
|
%
|
|
$
|
(33,861
|
)
|
|
(18.61
|
)%
|
|
$
|
(76,853
|
)
|
|
(42.25
|
)%
|
TBAs
|
|
(9,348
|
)
|
|
(5.14
|
)%
|
|
(14,783
|
)
|
|
(8.13
|
)%
|
|
13,262
|
|
|
7.29
|
%
|
|
30,437
|
|
|
16.73
|
%
|
Non-Agency RMBS
|
|
240
|
|
|
0.13
|
%
|
|
483
|
|
|
0.27
|
%
|
|
(238
|
)
|
|
(0.13
|
)%
|
|
(473
|
)
|
|
(0.26
|
)%
|
U.S. Treasury Securities, Interest Rate Swaps, and Futures
|
|
(17,280
|
)
|
|
(9.50
|
)%
|
|
(35,220
|
)
|
|
(19.36
|
)%
|
|
16,620
|
|
|
9.14
|
%
|
|
32,579
|
|
|
17.91
|
%
|
Repurchase and Reverse Repurchase Agreements
|
|
(881
|
)
|
|
(0.48
|
)%
|
|
(1,760
|
)
|
|
(0.97
|
)%
|
|
881
|
|
|
0.48
|
%
|
|
1,761
|
|
|
0.97
|
%
|
Total
|
|
$
|
(2,541
|
)
|
|
(1.40
|
)%
|
|
$
|
(10,958
|
)
|
|
(6.02
|
)%
|
|
$
|
(3,336
|
)
|
|
(1.83
|
)%
|
|
$
|
(12,549
|
)
|
|
(6.90
|
)%
|
Our analysis of interest rate risk is derived from Ellington's proprietary models as well as third-party information and analytics. Many assumptions have been made in connection with the calculations set forth in the table above and, as such, there can be no assurance that assumed events will occur or that other events will not occur that would affect the outcomes. For example, for each hypothetical immediate shift in interest rates, assumptions have been made as to the response of mortgage prepayment rates, the shape of the yield curve, and market volatilities of interest rates; each of the foregoing factors can significantly and adversely affect the fair value of our interest rate sensitive instruments.
The above analysis utilizes assumptions and estimates based on management's judgment and experience, and relies on financial models, which are inherently imperfect; in fact, different models can produce different results for the same securities.
While the table above reflects the estimated impacts of immediate parallel interest rate increases and decreases on specific categories of instruments in our portfolio, we intend to actively trade many of the instruments in our portfolio and intend to diversify our portfolio to reflect a portfolio comprised primarily of Agency RMBS, and, to a lesser extent, non-Agency RMBS and mortgage-related assets. Therefore, our current or future portfolios may have risks that differ significantly from those of our
June 30, 2017
portfolio estimated above. Moreover, the impact of changing interest rates on fair value can change significantly when interest rates change by a greater amount than the hypothetical shifts assumed above. Furthermore, our portfolio is subject to many risks other than interest rate risks, and these additional risks may or may not be correlated with changes in interest rates. For all of the foregoing reasons and others, the table above is for illustrative purposes only and actual changes in interest rates would likely cause changes in the actual fair value of our portfolio that would differ from those presented above, and such differences might be significant and adverse. See "
Special Note Regarding Forward-Looking Statements
."
Prepayment Risk
Prepayment risk is the risk of change, whether an increase or a decrease, in the rate at which principal is returned in respect to mortgage loans underlying RMBS, including both through voluntary prepayments and through liquidations due to defaults and foreclosures. This rate of prepayment is affected by a variety of factors, including the prevailing level of interest rates as well as economic, demographic, tax, social, legal, and other factors. Changes in prepayment rates will have varying effects on the different types of securities in our portfolio, and we attempt to take these effects into account in making asset management decisions. Additionally, increases in prepayment rates may cause us to experience losses on our investment in interest-only securities, or "IOs," and inverse interest only securities, or "IIOs," as these securities are extremely sensitive to prepayment rates. Finally, prepayment rates, besides being subject to interest rates and borrower behavior, are also substantially affected by government policy and regulation.
Credit Risk
We are subject to credit risk in connection with our assets, especially our non-Agency RMBS. Credit losses on real estate loans underlying our non-Agency RMBS can occur for many reasons, including, but not limited to, poor origination practices, fraud, faulty appraisals, documentation errors, poor underwriting, legal errors, poor servicing practices, weak economic conditions, decline in the value of homes, special hazards, earthquakes and other natural events, over-leveraging of the borrower on the property, reduction in market rents and occupancies and poor property management services in the case of rented homes, changes in legal protections for lenders, reduction in personal income, job loss, and personal events such as divorce or health problems. Property values are subject to volatility and may be affected adversely by a number of factors, including, but not limited to, national, regional, and local economic conditions (which may be adversely affected by industry slowdowns and other factors), local real estate conditions (such as an oversupply of housing), changes or continued weakness in specific industry segments, construction quality, age and design, demographic factors, and retroactive changes to building or similar codes. For mortgage-related instruments, the two primary components of credit risk are default risk and severity risk.
Default Risk
Default risk is the risk that borrowers will fail to make principal and interest payments on their mortgage loans. Subject to qualifying and maintaining our qualification as a REIT and our exclusion from registration under the Investment Company Act, we may selectively attempt to mitigate our default risk by, among other things, opportunistically entering into credit default swaps and total return swaps. These instruments can reference various RMBS indices, corporate bond indices, or corporate entities, such as publicly traded REITs. We also rely on third-party mortgage servicers to mitigate our default risk, but such third-party mortgage servicers may have little or no economic incentive to mitigate loan default rates.
Severity Risk
Severity risk is the risk of loss upon a borrower default on a mortgage loan underlying our RMBS. Severity risk includes the risk of loss of value of the property underlying the mortgage loan as well as the risk of loss associated with taking over the property, including foreclosure costs. We rely on third-party mortgage servicers to mitigate our severity risk, but such third-party mortgage servicers may have little or no economic incentive to mitigate loan loss severities. Such mitigation efforts may include loan modification programs and prompt foreclosure and property liquidation following a default.
Item 4. Controls and Procedures
Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC, and that such information is accumulated and communicated to our management as appropriate to allow timely decisions regarding required disclosures. An evaluation was performed under the
supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) as of June 30, 2017. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of June 30, 2017.
Internal Control Over Financial Reporting
There have been no changes in our internal control over financial reporting that occurred during the three month period ended June 30, 2017 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.